LGFA auction likely to be weaker due to factors such as size of issuance, duration risk, swap spread compression and proximity to FOMC meeting

By Kymberly Martin

It was another fairly quiet day domestically as the market remains in a holding pattern ahead of tomorrow morning’s US FOMC meeting. Overnight, US 10-year yields consolidated around 2.18%.

NZ 2-year swap nudged as high as 3.08% on the day before closing at 3.07%. We continue to see steady demand to pay swaps from the ‘real economy’.

We therefore believe that future dips in yields, along the way to higher yields by year-end, may prove fairly shallow.

The 2-10s swap curve sits around 114bps.The fate of the NZ curve, near-term, is in the hands of the US Fed.

If its announcement and comments early tomorrow morning (NZT) result in a further sell-off in US long bonds, the long-end of the NZ curve will likely follow. i.e a steeper NZ curve. Still, we think the 95-125bps range for the 2s-10s curve is well entrenched and would be difficult to break.

Overnight, offshore markets also seemed to be somewhat in ‘wait and see’ mode. Data delivery did not provided any significant surprises.

The June German ZEW survey of the economy showed current conditions fairly stable at 8.6 (9.5 expected). More importantly, forward-looking economic sentiment moved up the 38.5 (38.1 expected). German 10-year bonds sold off with yields rising from 1.53% to 1.57%.

Peripheral Eurozone spreads to German bonds remain fairly well behaved at present, as the Eurozone has failed to provide any shocking headlines of late.

Today will also bring the latest NZ Local Government Funding Agency auction. The offering is of $15m of LGFA17s and $270m of $LGFA21s. We suspect it is likely to see softer demand than at previous events.

This is due to the size of issuance, duration risk, recent swap spreads compression and proximity of the FOMC meeting. We would not be surprised to see a reduction in bid-to-cover ratios for the tenders, and/or long tails in the bidding.